MPEL: COULD THE SHAREHOLDER MEETING BE A CATALYST?

MPEL’s special shareholder meeting tonight could provide some long overdue clarity.

MPEL’s stock has been hammered – absolutely hammered. While all the Macau stocks have been crushed as investors replay 2008 in their heads, MPEL has underperformed even this pitiful collection of stocks. Despite all the rumors and storytelling, the fact is that investors fear that a slowing China economy and tighter credit will pressure junket volumes similar to 2008 and that is the reason these stocks are down.

For Q3, MPEL fell 35% but that was concentrated in September when the stock fell 36%. By comparison, the US operators with casinos in Macau fell an average of 23% and 24% in Q3 and September, respectively, while the Hong Kong listed Macau stocks dropped 30% and 41%. In October, MPEL is down again, -4%, but this pales in comparison to the HK listed stocks which are down 19% already this month.

MPEL now trades at around 5x 2012 EV/EBITDA which seems ridiculous. Investors clearly don’t believe that current Macau run rate revenues are sustainable but that doesn’t explain the relative valuation discount. So why so cheap?

Despite the US listing, MPEL is considered an Asian stock and US investors implicitly trust the US operators more. As shown above, the HK stocks have underperformed, sometimes even more so than MPEL. Similar among the HK stocks, public shareholders have little control over the entity given the concentrated ownership – for MPEL, Melco and Crown control almost 70% of the stock.

Shareholder dilution – as one of my smart clients has asked “do these guys really want to be known as serial diluters?” More on this later.

Recent performance is not sustainable – What? MPEL has consistently grown market share and margins since the management change in the middle of 2010. And they aren’t necessarily buying the business as EBITDA has grown faster than revenues and the company has beaten bottom line expectations (hold adjusted) for 4 straight quarters.

So what could be a catalyst to turn this thing around? First, a rate cut or some other macro measure by the Chinese government to show it is focused on ensuring a soft landing would help all the Macau stocks. For MPEL in particular, we are pretty sure they will beat the quarter, potentially beating Q3 EBITDA estimates by 40%.

Most immediate, MPEL will hold a special shareholder meeting tonight to discuss and vote on a listing on the Hong Kong exchange and a stock buyback. Investors rightly fear a big dilutive equity raise. This seems to be priced into the stock. We are hard pressed to believe that MPEL would do a straight equity raise at 5x EV/EBITDA. With cash trapped at the parent due to restrictions from the $600 million senior notes, MPEL eventually needs to raise cash or pay off the notes. We opt for the latter, of course.

So the options for MPEL are as follows:

A big equity raise $250-300 million – probably in the stock already

Cancelling the HK listing – would be a huge positive for the stock

Going forward with the listing but buying an equal amount of stock of MPEL to offset dilution but still add the second listing – this would squeeze the shorts

A substantially smaller IPO – probably a positive

The prospectus is supposed to be offered sometime this month. Hopefully , we will know more details tonight.

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10/05/11 09:13 AM EDT

THE HBM: YUM, MCD

THE HEDGEYE BREAKFAST MONITOR

SUBSECTOR PERFORMANCE

On yesterday’s short-covering opportunity, which yesterday’s Early Look had predicted, casual dining outperformed peer subsectors. Food processors saw more muted gains on the day but continue to trade well as grain costs slide.

QUICK SERVICE

YUM reported earnings yesterday after the close. EPS beat expectations by a penny, coming in at $0.83. The stock is trading down premarket due to concerns about the quality of the beat (tax rate) and China margin pressure. China comps accelerated to +19%, confirming our confidence in YUM's China business following a recent trip to the country. Management is hosting the earnings call this morning.

MCD Japan SSS gained 4.8% in September. This is the first time in three months that the monthly comp number has been positive. The company attributed the gain to a change in lifestyle patterns after the lifting of the government-mandated electricity saving request on September 9th.

Howard Penney

Managing Director

Rory Green

Analyst

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10/05/11 08:39 AM EDT

Retail: Pre-Announcement Time

With companies set to report September sales on Thursday, retailers have greater visibility into not only Q3 results with two months now in the books, but also how they are tracking into year-end. If retailers are looking at the same Macro setup we are and the number of companies that have beat versus missed on the sales line over the last three months is any indication, we expect to see the first phase of pre-announcements from retailers later this week.

The key BTS August selling season was choppy at best and our sense is that many retailers, especially on the discretionary side, underestimated the percent of sales that were lost forever instead of pushed into September due to Irene. To date, there hasn’t been much from retailers suggesting slower than expected sales with perhaps the sole exception of KSS at a competitor’s conference earlier in the month. Since then, the Macro setup hasn’t changed and in fact, current economic pressures have mounted even further.

Let’s review the setup from a Macro level:

Gross Personal Income was running up +3.6% and about to increase to over 4% compared to +3.3% today. (negative point)

The two main levers that account for the delta between Gross Income and Personal Consumption have offset each other for the most part.

The consolidated personal tax rate is now at 10.8% vs. 9.4% this time last year. (negative point)

The personal savings rate is back down to +4.5% compared to +5.8%.

In looking at ‘Essential Spending’ (food, energy, healthcare), the growth we’ve seen from June last year at (+2.6%) to May (+4.4%) has come in to +3.1%. (positive point)

The balance of spending goes into the ‘Discretionary Spending’ line, which is considerably more volatile. This stood at +12.2% this time last year compared to +11.8% in August.

In addition, consumer confidence is at 45.4 compared to 48.6 last year and unemployment is looking increasingly likely to weaken further before getting better near-term.

Based on our read out of POS data (NPD & SportScan), sales in September picked up later in the month in the department store channel, but remain uninspiring. In addition, weekly ICSC retail sales continued to decelerate throughout the month.

We think that sales day and likelihood of pre-announcement activity is going to reveal a key crack as it relates to the margin weakness and unsustainable earnings expectations in retail. The tailwind in consumer income growth is shifting and relief in the form of lower taxes unlikely. A further reduction in the personal savings rate is one of the few levers left for the consumer to pull, but would in turn place the consumer on even shakier ground heading into the 1H of F12.

Shorts: JCP, UA, HBI, SHLD

Longs: LIZ, NKE, RL, TGT

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Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

CHART OF THE DAY: Nifty Adventures

Nifty Adventures

“Adventure is just bad planning.” -Roald Amundsen

Yesterday, in the Early Look Keith wrote the following:

“Again, I’m not calling for a new bull market. Neither am I saying that Growth Slowing has ended. I am simply suggesting that you see this for what it is in most things US Equities (and some things Asian and European Equities) this morning – a Short Covering Opportunity.”

Call us lucky or good, but with the SP500 moving 44 handles upwards in the last 45 minutes yesterday, yesterday was a short covering opportunity indeed.

A key point underscoring that call yesterday was that global macro fundamentals, on the margin, were not getting worse. Alongside that, of course, was that consensus was hyper bearish. I was reminded of that this morning when I saw an advertisement on Google that was trying to sell a list of banks that are “doomed to fail”.

Certainly, we have a bearish view on the global banking system. That said, when companies start running advertisements to sell lists of banks that are “doomed to fail”, the surest takeaway is that a lot of the bad news surrounding bank failures is priced in over the short term. In the Chart of the Day, we’ve flagged this advertisement.

The other positive catalyst for global equities today is Moody’s downgrade of Italian government debt by 3 notches. To the credit of Moody’s, the ratings agency has at least gone from being completely irrelevant and wrong to being a classic contrarian signaler. The market decides when debt is downgraded, not Moody’s, and the market downgraded Italy many months ago.

Our view of Europe is that it would require a crisis to lead to an appropriate action that would at least lead to a reprieve in the European debt crisis contagion in the short term. Yesterday, the crisis came in the form of Dexia, the largest bank in Belgium. Dexia is also a significant global banking player and is roughly twice the size of Washington Mutual for comparative purposes.

The negative rumors out on Dexia yesterday were rampant. There was speculation that an emergency board meeting had been called to discuss Dexia’s accounting for Greek debt. Rumors suggested that a breakup of the bank was imminent. To raise capital, the bank was supposedly preparing to sell its profitable Turkish and Asset Management businesses. Etc. Etc.

In the case of Dexia, we should be clear, where there is smoke there is fire. In a chart that we have flagged numerous times over the last couple quarters comparing tangible equity to tangible assets of European banks, Dexia is by far the worst capitalized of the major European lenders at 1.5%. (Incidentally, Deutsche Bank is the fourth worst capitalized bank in Europe at 2.8% tangible equity to tangible assets.)

As with any global economic crisis, though, comes a great Keynesian opportunity. Last night the Belgian Prime Minister put his Keynesian cards on the table and said the following on national radio:

“One of the possibilities to consolidate Dexia Bank Belgium is, at a certain point, to ensure that it is taken up by the government.”

To this hockey head, that sounds like an explicit back stop for Dexia and, at least, a short term reprieve for the weakest major bank in Europe.

The other marginal positive from Europe, which was a key catalyst for U.S. equities yesterday, was an article from the Financial Times that Eurozone officials are examining ways of recapitalizing banks. Like an addict, the first step in solving your problem is actually admitting you have one. After months of denial, European officials leaking that they will recapitalize bad banks is an admission of their problem and a short term positive.

In addition, German President Angela Merkel made the following statement yesterday:

“No one can say for certainty what would happen if Greece defaults. Before I make a nifty step into an adventure, I have to ask whether we can really handle this and can we oversee what we are doing? Solidarity is always cheaper than if we were to go it alone and wind up with the problem Switzerland has . . . that the currency level is so high that you can’t export any products anymore. Today, going it alone is not path to a better future.”

Not surprisingly, Merkel sums up German situations quite adroitly. On one hand, Germany has and will continue to bear the bulk of the financial responsibility of Europe’s Sovereign Debt Dichotomy. On the other hand, German has been a major economic beneficiary of a common currency in the Eurozone.

Undoubtedly Merkel has not forgotten 1992 to 1995, the last time that other European economies found their combination of demand growth and real exchange rates against the German economy unsustainable. The results were massive and abrupt depreciations against the Deutsche Mark. In turn, the appreciation of the Deutsche Mark against Germany’s key trading partners led to a collapse in German exports and competitiveness. Despite internal politicking, the Germans ultimately understand that the Euro benefits them.

And so the nifty adventure in Europe continues.

Keep your head up and stick on the ice,

Daryl G. Jones

Director of Research

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10/05/11 08:03 AM EDT

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - October 4, 2011

Yesterday’s “Short Covering Opportunity” call was Keith’s third in the last two months (August 8th and September 12th were the other 2 time stamps).

As we look at today’s set up for the S&P 500, the range is 45 points or -2.49% downside to 1096 and 1.52% upside to 1141.

SECTOR AND GLOBAL PERFORMANCE

EQUITY SENTIMENT:

ADVANCE/DECLINE LINE: 633 (-2498)

VOLUME: NYSE 1662.1 (+18.4% )

VIX: 40.82 -10.2% YTD PERFORMANCE: +129.97%

SPX PUT/CALL RATIO: 2.00 from 1.97 (+1.5%)

CREDIT/ECONOMIC MARKET LOOK:

TED SPREAD: 38.09

3-MONTH T-BILL YIELD: 0.00%

10-Year: 1.85 from 1.82

YIELD CURVE: 1.60 from 1.57

MACRO DATA POINTS (Bloomberg Estimates):

7 a.m.: MBA Mortgage Applications, prior 9.3%

7:30 a.m.: Challenger job cuts, prior 47.0%

8:15 a.m.: ADP employer, est. 73k, prior 91k

10 a.m.: ISM Non-manufacturing, est. 52.8, prior 53.3

10:30 a.m.: DoE inventories

11 a.m.: U.S. to purchase $1b-$1.5b TIPS

WHAT TO WATCH:

Bank of New York Mellon sued by U.S., New York for allegedly defrauding clients in FX trades

GOLD – Hedgeye made a short call in Gold yesterday (before the down move) as Gold failed at the intermediate-term

TREND line of resistance ($1672); first support = $1573 and the long-term TAIL of support is all the way down at $1491; KM expects Gold to come under increasing selling pressure as 2yr UST rates hold the TRADE line of 0.21% support.

MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:

Commodities Climb From 10-Month Low as Bernanke May Buoy Growth

OPEC Risks Bear Market as Libyan Output Recovers: Energy Markets

Copper Rout Unlikely to Halt Chile $67 Billion Bet: Commodities

Indonesia May Sell More Palm Oil to China, Hurting Prices

Gold Declines in London as Dollar’s Rally Cuts Investor Demand

Corn Gains on Speculation 26% Slump May Attract China Purchases

Sugar Advances as Lower Prices May Spur Buying; Coffee Climbs

Copper Rises on Speculation Officials Are Set to Stoke Recovery

Commodities to Rally in ’12, Says Credit Suisse Joining Goldman

Silver Rebound May Stall at $33.15 an Ounce: Technical Analysis

Australian Grain Regions May Get Crop-Boosting Rain This Week

Chile’s Richest Family Risks Golden Touch With Shipping: Freight

Komatsu Risk at 2-Year High on Yen, Economic Slump: Japan Credit

Oil Rises From Lowest in a Year on Supply Drop, Stimulus Hopes

Palm Oil Drops to 1-Year Low as Malaysian Reserves Set to Climb

Rubber May Extend Drop to Lowest Since 2009: Technical Analysis

CURRENCIES

EUROPEAN MARKETS

The Russian stock market crash matters; the RTSI is flagging a negative divergence vs the rally in Europe DAX to lower highs; Russia = down -1.6% this morn and down, get this, -43% since April when the down Dollar/up inflation trade stopped! Get the USD right; you’ll get a lot more right.

ASIAN MARKETS

MIDDLE EAST

Howard Penney

Managing Director

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